The Underpants Gnomes Applied to VC Backed Companies

From Adam Smith at Square 1 Bank on how NOT to pitch your company to a VC.

The full segment is below.

There is a philosophy that "all you need to do is get tons of underpants traffic and good things will happen. When that works, it’s a beautiful thing. The key word – of course – is "when." Phase 2 is a dangerous place.

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It seems as though tech companies that are able to attract a large amount of traffic do indeed become very valuable companies, whether or not they have a fancy business model. Even companies such as Digg and Meebo, largely derided as having no business model, are now being shopped for $100's of millions. However, all VC's and entrepreneurs tend to insist that startups need a business model beyond advertising.

Am I missing something? Can you name several tech companies that were able to attract tens of millions (or even millions) of regular users but weren't able to convert that traffic into significant levels of revenue within a few years?

Friendster received a post-bubble acquisition offer for $30 million from Google. Their value went down after that because they executed poorly and lost their users, not because they had any less of a business model than Facebook, MySpace, or Bebo. It's not that they had a bunch of underpants they couldn't figure out how to monetize, but that they couldn't hold onto the underpants they had.

(And, though it's unrelated my argument, they now have 50 million active users and received a Series C from Benchmark, DAG, and Kleiner Perkins. Friendster is known as a failure not because they truly failed to become a *valuable* company, but because they blew the opportunity to become a billion-dollar company.)

To qualify my previous question: can you name any companies that have *sustained* a large active user base and failed to monetize or be acquired for several millions of dollars? Let's separate execution issues from business model issues.

Tweek Harbuck

Hey Brad – I'm really curious to see if you have any more examples. I hear similar comments from VCs and entrepreneurs all the time. While advertising has long been accepted as a business model for TV, radio, magazines, and newspapers, people don't seem willing to accept it as a model for websites; everyone wants something more sophisticated. Is there in fact an established history of great sites being unable to monetize a large, dedicated user base through advertising (or at least sell their site to a larger entity that found their users valuable)? Or are the oft-mentioned failures due to poor execution and over-spending?

Tweek Harbuck

It seems as though tech companies that are able to attract a large amount of traffic do indeed become very valuable companies, whether or not they have a fancy business model. Even companies such as Digg and Meebo, largely derided as having no business model, are now being shopped for $100's of millions. However, all VC's and entrepreneurs tend to insist that startups need a business model beyond advertising.

Am I missing something? Can you name several tech companies that were able to attract tens of millions (or even millions) of regular users but weren't able to convert that traffic into significant levels of revenue within a few years?

Friendster received a post-bubble acquisition offer for $30 million from Google. Their value went down after that because they executed poorly and lost their users, not because they had any less of a business model than Facebook, MySpace, or Bebo. It's not that they had a bunch of underpants they couldn't figure out how to monetize, but that they couldn't hold onto the underpants they had.

(And, though it's unrelated my argument, they now have 50 million active users and received a Series C from Benchmark, DAG, and Kleiner Perkins. Friendster is known as a failure not because they truly failed to become a *valuable* company, but because they blew the opportunity to become a billion-dollar company.)

To qualify my previous question: can you name any companies that have *sustained* a large active user base and failed to monetize or be acquired for several millions of dollars? Let's separate execution issues from business model issues.

Tweek Harbuck

Hey Brad – I'm really curious to see if you have any more examples. I hear similar comments from VCs and entrepreneurs all the time. While advertising has long been accepted as a business model for TV, radio, magazines, and newspapers, people don't seem willing to accept it as a model for websites; everyone wants something more sophisticated. Is there in fact an established history of great sites being unable to monetize a large, dedicated user base through advertising (or at least sell their site to a larger entity that found their users valuable)? Or are the oft-mentioned failures due to poor execution and over-spending?